Carney Policy Will Fight to Be Heard in Fed World: U.K. Credit

Mark Carney takes the Bank of England
helm today facing a struggle to make his policies count more
than those of his U.S. counterpart for U.K. government debt.

Gilts ended their worst quarterly performance since 2008
last week after a selloff fueled by Federal Reserve Chairman Ben
S. Bernanke’s outline for reducing U.S. asset purchases. The
securities made a loss even as outgoing Bank of England Governor
Mervyn King sought to persuade fellow Monetary Policy Committee
members to add stimulus and amid speculation Carney will
introduce new policy tools to boost growth.

“Gilts have pretty much tracked U.S. Treasury notes and we
think that’s a little bit surprising, frankly, because as many
MPC members have been keen to tell us in the last couple of
weeks, the U.K. economy is not in the same place as the U.S.,”
Michael Amey, a money manager at Pacific Investment Management
Co. in London, said in a June 28 interview on Bloomberg
Television’s ‘The Pulse’ with Francine Lacqua and Guy Johnson.
“The U.K. has overshot and rate hikes here are a long way
off.” Pimco, based in Newport Beach, California, manages the
world’s biggest bond fund.

The benchmark 10-year gilt yield climbed to 2.59 percent on
June 24, the highest since October 2011 and up from a record-low
1.41 percent set on July 23 last year. The rate rose four basis
points to 2.48 percent at 8:55 a.m. London time today, below its
five-year average of 3.03 percent.

Gilt Losses

U.K. government bonds lost 3.9 percent in the second
quarter, their worst performance since the three months ended
June 2008, Bank of America Merrill Lynch indexes show.
Securities in the Global Broad Market Sovereign Plus Index lost
1.7 percent in the same period, set for the worst performance
since the end of 2010.

Fixed-income assets tumbled after Bernanke said on May 22
the Fed could cut the pace of its bond purchases, known as
quantitative easing, if policy makers saw indications of
sustained economic growth. The central bank may reduce monetary
stimulus this year and end it in mid-2014, he said on June 19.

“The U.S. QE tapering talk has clearly hit all sovereign
yields globally, including gilts, as investors start to worry
that the massive flood of monetary stimulus is going to start
ebbing,” said John Wraith, a fixed-income strategist at Bank of
America Corp. in London. “We do think the selloff is overdone,
and that yields will come a bit lower of their own accord. But
we very much doubt we’ll see them go back towards their lows,
because that would take full QE commitment from the BOE, and
probably the Fed, and both look unlikely to us.”

Recovery Signs

Gilts’ 3.8 percent drop last quarter was the biggest among
26 sovereign-debt markets tracked by Bloomberg and the European
Federation of Financial Analysts Societies indexes with New
Zealand and Denmark the next-worst. German government securities
fell 1.8 percent and U.S. Treasuries slumped 2.3 percent.

Gilt yields were also boosted as data showed the economy is
gaining momentum after a return to growth in the first quarter.
The Office for National Statistics revised higher 2012 data last
week to show that the U.K. avoided a second recession, as
previously reported. Data last month showed services,
construction and manufacturing all grew in May, supporting the
case for the Bank of England to refrain from more bond buying.

‘Global Phenomenon’

The U.K.’s bond-buying target has been unchanged at 375
billion pounds ($571 billion) since July last year, and the
central bank completed its last round of purchases in November.
Minutes of King’s final MPC meeting published on June 19 showed
he suffered a fifth consecutive defeat in a push to expand
quantitative easing. The benchmark interest rate has been at a
record-low 0.5 percent since March 2009.

“We’ve stopped doing QE before the U.S. even suggested it
might happen,” said George Buckley, chief U.K. economist at
Deutsche Bank AG in London. “At 1.60 or 1.70 percent, gilt
yields are too low unless you believe growth will stagnate for a
long, long time.”

The rate on 10-year gilts will fall 23 basis points to 2.25
percent by the end of the year, according to the median of 22
analyst estimates compiled by Bloomberg. U.S. 10-year yields
will end 2013 at 2.35 percent, separate forecasts show.

‘Nuclear Option’

Carney’s scope to hold down gilt yields as the Fed exits
its bond-purchase plan is “limited,” especially on securities
due in more than five years, according to Sebastian Mackay, an
investment director for fixed income at Standard Life
Investments, Edinburgh’s largest fund company. “The principal
driver of the rise in gilt yields has been the realization that
the point of maximum global monetary stimulus has probably
passed,” he said.

Carney may opt to introduce some form of forward guidance
or other growth-nurturing tools, which would “add
credibility,” according to Mackay. Chancellor of the Exchequer
George Osborne revamped the central bank’s remit in March to
give policy makers more flexibility to add to stimulus.

“He is more likely to pursue other policy innovations
including guidance in particular” and “see QE as a sort of
nuclear option to be relaunched if something goes badly wrong,
rather than a policy for use in the current relatively steady
state,” Wraith at Bank of America said. “We don’t think U.K.
QE is coming back.”